Charter schools can participate in government retirement plans

Wading into an area in which it has never issued guidance, the IRS announced on Friday that it will develop regulations under Sec. 414(d) that would permit a state or local retirement system that qualifies as a governmental plan to cover employees of charter schools (Notice 2015-7).

The IRS has developed this new stance in response to over 2,000 comments it received from the charter school community, who were concerned that regulations under consideration to define “governmental plan” would deter governmental plans from permitting charter schools to participate, which, in turn, would hurt charter schools’ ability to attract and retain teachers.     

For purposes of the rules governing pension plans, Sec. 414(d) defines a “governmental plan” as “a plan  established and maintained for its employees by the Government of the United States, by the government of any State or political subdivision thereof, or by any agency or instrumentality of any of the foregoing.” However, there are no regulations interpreting Sec. 414(d) or defining terms such as “established and maintained,” “political subdivision,” “agency,” or “instrumentality.”

The IRS is proposing to issue regulations that would say that a state or local retirement system will not fail to be a governmental plan merely because it permits employees of a charter school to participate in the plan, provided that the school satisfies the following requirements:

• The school must be a nonsectarian, independent public school that serves a governmental purpose by providing tuition-free elementary or secondary education, or both.
• It must be established and operated in accordance with a specific state statute authorizing charter schools or independent public schools.
• Applicable law must expressly permit or require the school’s employees to participate in the state or local retirement plan.
• The school must meet either of these requirements:

1. The school’s governing board or body is controlled by a state, a political subdivision of a state, or an agency or instrumentality of a state or of a political subdivision; or
2. The school’s primary funding is from a state, a political subdivision of a state, or an agency or instrumentality; the school’s employees’ rights to their benefits accrued under the state or local retirement system do not depend on whether the school continues to participate in the system and if the school ceases participation, a governmental school has responsibility for the accrued benefits of the school’s employees; and the school is part of a local educational agency or is its own local educational agency and is subject to the significant regulatory control and oversight.

• The school must be fully owned by a state, a political subdivision of a state, or an agency or instrumentality of a state or of a political subdivision of a state. This means that, upon dissolution or final liquidation, the school’s governing documents require the school’s net assets to be distributed to another public school.

So far, the IRS has merely announced its intention to issue proposed regulations that embody these principles. The new rules will not be effective until they are finalized, and they are intended to apply prospectively. However, the IRS anticipates that the final rules will provide that a plan that meets these requirements when the regulations go into effect and provided these benefits before the regulations were in effect will be considered a governmental plan under Sec. 414(d).

—Sally P. Schreiber (sschreiber@aicpa.org) is a JofA senior editor.